Earnings growth though slightly lower, still looks fairly on track, Mahesh Patil, Co-CIO, Aditya Birla Sun Life 66326867

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Mutual Fund, tells ET Now. Patil also says that value is emerging in utilities, pharma and metal sectors. Some of the good quality NBFCs are also available cheap now. Edited excerpts: Good, bad or ugly, how is it looking? It has been a kind of terrible period, especially in the broader market. We have again seen a fresh round of selling and it started off with all the financials. There are a lot of fears and all sorts of rumours are being spread. That has caused some kind of panic in the financial service space and that is spilling on to the broader markets.To compound that, on the global front also, there is some kind of correction including in the US market. The US economy is, however, still doing very well. It is a combination of domestic factors as well as the global markets seeing some correction, has led to this fall. As a local investor, how much credence would you give to global factors impacting our sentiment versus local factors pegging us back? Global factors matter really because FIIs have been selling now for quite some time. In the last two quarters, FII flows have been negative and year till date, we are almost $5 billion negative which is one of the largest kind of numbers. Domestic flows, on the other hand, have been pretty steady at around Rs 9,000-10,000 crore, which have been balancing those things. I would say that the global factors are important but currently the correction in our markets is more to do with local factors really and the confidence seeking needs to be really bottomed into the financial services space to get back some kind of stability in our markets at this point in time.Earnings are also coming in this quarter. We have seen some kind of earnings in the initial period and we are seeing some margin pressure. That was a concern this time around because commodity prices had gone up and the rupee depreciation led to a downgrade in earnings. But we have to wait and watch and see how these earnings goes by because that really gives support to the market at a time when other factors are looking a bit negative. Since local factors are leading to correction in our market, what kind of approach for stock or sector selection would you adopt – top-down or bottom-up? Lots of stocks and even the Nifty probably is down around 10% or so. Some of stocks are down 20-30-40%. It is the right time to really do bottom-up stock picking. A lot of sectoral rotation is also happening. Sectors which have done well, are correcting now. In this fall, IT and consumer staples did very well. Stock specific approach would be the right approach in this kind of market environment where clearly value is emerging in a lot of stocks across sectors. When there is a lot of fear and panic, stock prices slip below their intrinsic value. That is where you get good entry points.But for somebody who is taking a slightly longer term view, it is a good stock pickers’ market and across sectors, it is the time to pick up better quality names to build a good long-term portfolio. What is your approach towards managing midcaps and small caps in this market? You are putting about 20% of your overall corpus in midcap and small cap funds. What is driving your conviction there? When there is fear in the market and the market is weak, we see midcap and smallcap stocks correct quite a bit. The smallcap index is down 40% from here its peak. So to a large extent, the stocks have corrected. They always overshot on the downside more than the largecaps when there is fear in the market. We had a largecap bias last year and beginning of the year. But with the correction in the midcap space, we are seeing stock-specific opportunity. In a way, we are largecap and midcap agonistic at this point in time. It clearly boils down to specific stocks. If we find good value in mid and smallcaps, we are happy to really look at those stocks in our portfolio. This is the time to dig down into your stocks, get better conviction because 20-30% fall in stock prices can actually shake your conviction. Would your conviction build more in a 40% fall in midcaps versus a 10-15% fall in largecaps? As said. it does not matter. It could be the 40% fall… Quality matters, you are getting quality 15% lower, you are getting higher risk… maybe risk your stocks 40% lower. In the mid and small cap space some of the stocks which have fallen 40% they might still not be worthy of investing anyway at those levels but that is the differentiation you have to make. Quality matters. It could be a good quality company or it could be a poor quality company with governance issues. This market is not forgiving for these kind of stocks. We have seen that and they will not bounce back soon, because we are not seeing liquidity come back into the market.As a fund manager, keeping the investors risk adjusted return profile in mind. how would you draw the balance? You are putting in 20% in mid and smallcaps, which means 80% goes into largecaps. Is that your bias? Again, if you look at the broader market, if you do a composition of that market cap weighted, you would see that 20-25% would be largecap and balance would be midcap. What we are actually doing is we are not really differentiating between large and midcaps. So 25% would be the larger, broader allocation towards the midcap and the smallcap space in a multicap fund. Largecap stocks also because in the small and midcap space, the liquidity is not good. When things are bad, that is where you can build a portfolio. Otherwise, these stocks are much costlier in a bullish market. You have to build that portfolio now in the stocks which you have identified earlier and you are comfortable holding on to, from a slightly longer term perspective. As the NBFC sector is facing challenges, is it possible that private sector banks which had lost market share to NBFCs, would again take that market share back. Would that compel some of the fund managers to allocate more weightage to private sector banks? Normally when liquidity tightens, any financial institution with good liability franchise is obviously going to stand much better and that is where banks have an advantage with their retail deposit base and large CASA ratios. There is opportunity for them to really increase their market share, especially on the retail side. That is where the NBFCs were taking a lot of market share. But having said that, the opportunity is still very large in that space. It is not like one is taking market share because a lot of NBFCs are reaching out to a lot of retail buyers which banks are not catering to. In this kind of environment, you will see a slowdown in terms of growth for the NBFC sector and that is being reflected in terms of the derating in a lot of the names. Obviously, in the current scenario, where liquidity is very tight and there is lot of fear, we are seeing the valuations undershoot in some of these names but strong franchises on the NBFC side with good liability and pricing power, should help them survive this and bounce back.At this point in time, the private banks are looking better placed and that is where there is more stability and visibility at this point in time.Recently you added Eicher Motors. Given the kind of cool off that we have seen in the entire auto pack, is it purely a valuation game here? I would not be stock specific but generally in the auto space, especially the two-wheeler space, there has been some kind of a slowdown compared to expectations that we are building for the year. There are multiple factors. The overall festive season has not been that great. Also, there has been a hike in vehicle prices with insurance premium having gone up significantly. There is also a switch towards the higher emission norms which is increasing the cost of the vehicle and slamming the brakes in terms of new buyers coming into the market. It is basically the overall pruning down of the growth numbers, where we have seen the stock PE multiples are getting reduced a bit. We think it is a transient phase and the market will adjust to the new prices. But in the near term, there has been a downgrade to our earnings and that is why we are slightly cautious on the space and the competitive intensity in the two-wheelers is also increasing with players wanting to get back market share.We are seeing some margin pressure coming in that sector. But the stocks have now corrected back to fairly good levels. The PE multiples have got to attractive levels. These companies are good free cash flow generating companies and clearly value is emerging but in the near term, number downgrade is imminent in this sector.Where else are you finding opportunity in the market right now? Some of the defensive sectors like utilities look good. There are pockets of opportunity in the pharma space and metals. Metal prices have been fairly steady and China also has shut down capacities and the overall cash flow generation in that space seems to be fairly strong. We are seeing deleveraging happen in that sector. So metals look good. Obviously one needs to watch out what happens on China, but for the time being that sector looks good. In the banking and financial services space, some of the NBFCs have also got beaten down to levels where the valuations are looking very attractive. This is a time to differentiate between the NBFCs. NBFCs which have got a very strong parentage, good liability franchise and are strong on the asset side, should be able to bounce back once this does settle down on the liquidity front. Would you say that there is still some attraction left when it comes to corporate banks or do you think much of the story is already behind us and in the price? The corporate bank story is starting to play out now. We have seen the overall NPA cycle peak out. We are seeing some recoveries from the NCLT, which is also helping. Recently, the kind of value Essar Steel got means whatever provisions the banks had made, there will be some kind of a write back over there. So, the corporate bank story will play out over the next few years and as a result of that, the overall credit cost will come down and the ROAs will improve. Even the overall credit growth will improve in the corporate banks side. It is still a long way to really play for the corporate banks and you would see the overall growth as well as the return ratios improve, making them a good proposition from a next two to three-year perspective. How are you mapping earnings from this quarter? So far, we have had a decent Q1. The Q2 earnings report so far has been luke warm-ish. Do you think we can be an aberration in this year’s earnings cycle versus what we did in FY18? Can FY19 hold the trajectory higher? The expectations for FY19 if you look at consensus would be around 19-20%. Our expectation is around 16% growth. We think it is possible. Some downgrade could happen after this quarter because of the tightening of liquidity. We could see some slowdown in terms of the consumer sales especially consumer discretionary like autos and consumer durables and that is something which we will know only after this festive season goes by. But apart from that, the numbers should be fine. We are seeing strong growth coming in from the metal space, some of the pharma sector and selectively in the media space. There are a lot of sectors would actually report positive growth except for the telecom sector where you would see a sharp negative kind of a growth. I would say first quarter was fairly decent, second quarter should also be okay. The overall growth should be somewhere around 10% or so and if the trajectory continues in the second half and you do not see any meaningful slowdown in terms of growth, we should be well on track for around 15% earnings growth for FY19. The three-year and five-year averages for equity are still favourable. But another 10% fall in largecap stocks and another 5% in smallcap stocks, could damage the returns. could be damaging. What happens to the investor sentiment in that case? Yes, up till now, the domestic investors have behaved very rationally and have been very calm in the market fall and the steady inflow what we are seeing in the SIP is maintaining its level. However, the big money which came in at the time of demonetisation, has gone away. But one has to wait and see how the markets correct further and if the long-term returns start to look pretty and in low single digits, then what the investor reaction would be. My sense is that even if they shoot down another 5-10%, markets should not linger there. It should bounce back because the overall fundamentals are improving.But if the long-term numbers start to look bit negative, one needs to watch out but the overall behaviour of investors has changed. The outlook is becoming much longer. Earlier, it used to be like one to two years, now it is three to five years timeframe. That gives us confidence that long-term money will stay in and the alternatives are not much. Agreed that the interest rates are going up and so some money would move into the debt side. But if you look at the other asset classes, neither real estate nor gold really offer any meaningful upside. I would say that you could see some slowdownm but the overall net positive flow that we are seeing should continue. If you were to define your stance on the market would you say that you are cautiously optimistic or do you believe that there is reason to be optimistic because the only way from here is higher? We have been cautious on the market for some time because a) the valuations were higher and the macros were kind of deteriorating. As every correction happens, there is a price for every stock in the market, While we are still cautious, this is the time when one should start to really deploy some of the cash that we have in our portfolio because we are seeing good value emerging and index at around 10,000 levels or below would be a good buying opportunity for a lot of investors who have been waiting on the sidelines and want to enter the market because the longer term picture still looks fairly intact. There is global growth also. While we are seeing a correction, the US is doing very well. And as I mentioned, earnings growth though slightly lower, still looks fairly on track.